Mild Corrective Forces Unfold

The light news stream, adequate bill auction receptions and comments from Fitch suggesting France’s AAA rating is secure this year encouraged short-term players to take profits. However, sentiment is still wholly euro negative and a large investment bank was out today with new calls to sell the euro. Resolution of credit watch decisions are still awaited from Moody’s and S&P.

Separately France defied expectations and contradicted poor PMI readings by posting a 1.1% jump in November industrial output. The consensus was for a 0.1-0.2% gain. The October series was revised higher to 0.1% form flat. The gains were broad based and give up that the economic slowdown is brief and shallow. Last month, the French stats office warned that the country’s GDP was likely to contract in Q4 11 and Q1 2012. The risk is that the increased output will find its way into inventories, changing the shape of the economic downturn.

The euro managed to move through yesterday’s highs, but the $1.2820 area, noted here yesterday, remains intact. This needs to be overcome to signal a deeper correction rather than a flattish consolidation. On the downside, support is seen in the $1.2720-40 range.

Unprecedented intervention by Japanese officials on October 31 may not have weakened the yen, but it has managed to suck volatility out of the market. The benchmark month implied volatility is slipping below 8% for the first time since late 2007. The dollar itself is about 2% above its record low JPY75.35 low. The most important development in Japan in recent weeks is the drive by the Noda government to press ahead with plans to double to retail sales tax to 10% by Oct 2015. The tax hike is ostensibly to offset the rising costs of social security costs.

Noda committed to the tax at last November’s G20 meeting, but it has a high domestic cost. Nine members of the DPJ have bolted in objection to form a new party and Noda’s support in the polls stands near 36%, according to a December Nikkei poll, off 30 percentage points since Noda assumed the post. Hikes in the sales tax in 1989 and 1997 were very divisive.

In terms of the legislative process, the cabinet approved the tax hike in two steps April 2014, from 5% to 8% and Oct 2015 a hiked form 8% to 10%) at the end of last week. The Diet is expected to consider the measure by the end of March. Passage is not assured and there is speculation that it may require a cabinet shake-up at the minimum Noda is threatening to turn it into a confidence motion. The dollar seems confie4nd to a JPY76-JPY78 trading range.

Lastly, China’s trade balance was a big surprise, nearly double the $8.8 bln surplus expected. The $16.5 bln trade surplus was a function an unexpected slide in imports. Exports rose 13.4% year-over-year in December, largely as expected, though still the smallest in 2-years. but the import growth slowed to 11.8% , which is half the Nov 22.1% pace and a two year low. The consensus had looked for a decline to 18%.

Considering China imports components and parts and exports finished goods, the decline in imports may say more about demand in China’s trading partners than it says about China. China will report GDP, retail sales, and investment figures next week.

China’s stock market has strung together a three day advance 6.4% advance the largest since in more than a year. Bottom picker and bargain hunters may be moving in as confidence grows that policy makers will take more monetary and fiscal stimulative measures. A move above 2300 in the Shanghai Composite would likely boost confidence that a material low is in place.

Marc Chandler joined Brown Brothers Harriman in October 2005 as the global head of currency strategy. Previously he was the chief currency strategist for HSBC Bank USA and Mellon Bank. In addition to frequently providing insight into the developments of the day to newspapers and news wires, Chandler's essays have been published in the Financial Times, Barron's, Euromoney, Corporate Finance, and Foreign Affairs. Marc appears often on business television and is a regular guest on CNBC and writes a blog called Marc to Market. Follow him on twitter.